Free Riding on Product Returns to Drive Profits

Abstract

Returning products has become standard practice for consumers and a significant “pain point” for retailers. The authors contend that returns can be harnessed to increase profits. Doing so requires retailers to manage the interweaving dynamics of product returns and purchases. The strategy is to comanage a virtuous cycle, whereby current returns increase future purchases, and a vicious cycle, whereby current returns increase future returns. Marketing executes the strategy by generating purchases, and the returns that follow impose a direct cost due to the vicious cycle. However, the virtuous cycle of returns can offset the vicious cycle, enabling the retailer to “free ride” on returns by optimizing its marketing. The approach follows the decision support system paradigm by combining a conceptual model, a statistical model, data, and optimization. A core construct is a stock variable tracking consumers’ memory of return experiences, which drives both the virtuous and vicious cycles. The authors optimize marketing spend while accounting for return stock. The best results occur when dynamics are incorporated into both the statistical and optimization models. The results suggest that managers should avoid strict return policies aimed at eliminating returns. Instead, they should design policies that optimally balance the long-term benefits and costs of returns.